Federal budget tax cuts likely –but will it be enough to offset falling consumer wealth?

Investors have been fretting about falling house prices and slowing economic growth in Australia and many are hoping that the Federal budget – to be handed down on April 2 – will contain some good news to help stimulate growth.

We believe the budget will contain positive news for the economy, but those benefits could be complicated by the looming Federal election.

Deficit down

Firstly, the budget is expected to show an improved fiscal position for the Government. We expect a budget deficit of $3 billion for 2018/19 – a smaller deficit than Treasury forecast in the mid-year economic outlook. We’re then likely to move to a surplus in 2019/20, or possibly even in the current financial year.

Government revenue is better than expected because iron ore prices have been running above Treasury estimates. But that is not expected to last with iron ore prices likely to come down a little bit.

Tax cuts

But the iron ore windfall will enable the Government to announce an election sweetener through tax cuts for households, which we expect will be the main policy in this year’s budget.

The Government already set aside about $3 billion for household tax cuts in the December mid-year economic outlook. The iron ore boost will provide an additional $3 billion for further tax cuts.

Approximately $6 billion worth of new tax cuts for households, equates to about 0.3 per cent of gross domestic product – which is not a huge amount but it will provide some relief for households.

The Government, however, has already put in place tax cuts from last year’s budget and that will add to that fiscal stimulus.

A major question for investors is whether any fiscal stimulus will be enough to offset falling house prices?

The wealth effect from falling house prices has been a drag on consumer spending and unfortunately, while tax cuts will help boost spending, we don’t think they will be enough to offset the drag from falling household wealth.

Promises vs delivery

While news of tax cuts should be positively received, there is no certainty they will be fully enacted in their current form if Labor wins the upcoming Federal election. The election is due to be held sometime in May, with the exact date to be announced after the budget.

The margin between Labor and the Coalition is expected to narrow as we get closer to the election, but polling currently shows Labor is favoured to win.

If that happens, Labor may choose to make some adjustments to the tax stimulus announced in the upcoming budget.

Labor has said it may provide some tax stimulus at the lower end of the income quintiles for households, so there’s a chance any tax stimulus announced will change.

Housing concerns

In addition to uncertainty around the implementation of tax cuts, a Labor Government could also increase the uncertainty around house prices.

Labor has flagged that it plans to make changes to the capital gains tax and also to negative gearing if it wins the election.

Given we’re in the middle of a house price downturn – home prices are down nationally by about eight per cent year on year to February and even more in Sydney and Melbourne – any further changes to housing market dynamics will come at an unnecessary time.

If Labor implements its changes, we think it could put further downward pressure on house prices, maybe by another five per cent or so. We could therefore see an even more significant downturn in the housing market.

Question marks

The Government is expected to announce other key policy measures in the budget including a reduction in the immigration cap from 190,000 to 160,000.

They could also boost infrastructure spending in the near term, particularly in rural areas which will be another positive for households because it will stimulate business spending and jobs growth.

But the main news will likely be tax cuts for households. The question is whether that will be enough to offset the impact of falling home prices on consumer spending.